Recently the Internal Revenue Service issued final regulations relating to the treatment of S corporations and their QSubs.
These regulations are intended to provide guidance, and in many instances the new regulations have clarified or eliminated QSub issues.
The transaction is a reorganization described in section 368(a)(1)(C), assuming the other conditions for reorganization treatment (e.g., continuity of business enterprise) are satisfied.
A qualified subchapter S subsidiary (QSub) is a subsidiary corporation 100% owned by an S corporation that has made a valid QSub election for the subsidiary (Sec. Because a QSub’s separate existence is ignored, transactions between the S corporation parent and QSub are not taken into account, and items of the subsidiary (including accumulated earnings and profits, passive investment income, and built-in gains) are considered items of the parent. A exception applies, it appears that the traditional organizational expenditures incurred in the process of forming or organizing a QSub continue to qualify for amortization under Sec. Amortization begins with the month each new business begins.
In quite a few other respects, however, the new regulations either have created new uncertainties, or have highlighted the importance of thorough planning, and given notice of potential traps.
This letter outlines important provisions of the new regulations you should be aware of when planning QSub transactions.
195 election, if it expands into a different industry or segment, such as wholesaling or retailing.
Note: This article originally appeared in the October 2012 Footnote.
This ruling describes situations where an S corporation undergoes a reorganization pursuant to section 368(a)(1)(F) of the Code where the operating S corporation becomes a QSub of a newly formed holding company. The ruling further holds that, effective 1/1/09, the new parent will have to get its own EIN rather than take over the QSub’s EIN. Section 368(a)(1)(F) provides that a reorganization includes a mere change in identity, form, or place of organization of one corporation, however effected.The QSub election terminates the QSub’s former identity as a separate entity for federal tax purposes. This final return generally includes the deemed liquidation transaction. An S corporation expanding an existing line of business can set up one or more QSubs to own the new same-line-of-business operations.A QSub is normally treated as a disregarded entity for all purposes of the Code (Secs. However, the IRS is authorized to treat it as a separate entity for certain purposes (Sec. Under this authority, the IRS has issued regulations that treat QSubs as separate entities for the following purposes: (1) employment taxes; (2) certain federal liabilities, refunds, and credits of federal tax; and (3) certain excise taxes. Accordingly, the QSub is liable for employment taxes on wages paid to its employees and is responsible for satisfying its other employment tax obligations (e.g., backup withholding, making timely deposits of employment taxes, filing returns, and providing wage statements to its employees on Forms W-2, Related corporations may avoid the overpayment of employment taxes for common employees by implementing a common paymaster system. Because these rules apply only to concurrently employed workers, each corporation remains responsible for the wages of its remaining employees. Expenditures paid to facilitate (i.e., an amount paid in the process of investigating or otherwise pursuing) the formation or organization of a disregarded entity, such as a QSub, must be capitalized under Sec. Since the QSubs are disregarded for federal tax purposes, a current deduction should be allowed for expansion costs of each QSub because they are treated as incurred by the existing S corporation rather than the QSub. The wholly owned subsidiary’s separate existence terminates for federal tax purposes.Corporation X, pursuant to a plan, acquires all of the outstanding stock of corporation Y from the shareholders of Y solely in exchange for 10 percent of the voting stock of X.Prior to the transaction, Y and its shareholders are unrelated to X.For a business reason such as segregation of assets and liabilities or maintenance of contractual obligations, it may be prudent to establish certain S corporation operations in a separate subsidiary.